Business model
JPMorgan was the leading investment bank globally as of December 2021, in terms of market share of revenue. During that time, the revenue of JPMorgan accounted for 9.6% of the global investment banking revenue. Goldman Sachs (NYSE:GS) followed, with a market share of 9%. The company makes its money from four main business segments:
1. Consumer and Community Banking
2. Corporate and Investment Banking,
3. Commercial Banking
4. Asset and Wealth Management
The companys Consumer and Community Banking revenue was down by 2.3% year-over-year in the first quarter as higher business banking revenues were offset by lower home lending revenue (due to low interest rates). There were also lower auto lending volumes due to vehicle shortages. Corporate and Investment Banking revenues were down 7.4% due to lower investment banking fees and a $524 million loss in credit adjustments partially influenced by Russia exposure.
Commercial Banking revenues were virtually flat, up just 0.2% year-over-year. Their Asset and Wealth Management revenues saw a big boost, up 5.8% year-over-year, due to growth in deposits and loans and higher management fees.
Fintech transformation
JPMorgan and many large incumbent banks have been facing increased competition from fintech startups all over the world. In order to keep their finger on the pulse of the disruptors, they have been on a spree of fintech acquisitions and partnerships since 2020, in addition to investing a staggering $12 billion a year into their own fintech offerings.
However, now JPMorgan is planning a radical transformation which will reorganize the company into a “collection of startup companies” with 25 Mini CEOs at the helm. They will focus on a product-centered approach which involves fast iteration and lean software development techniques used commonly at tech companies.
According to Monika Panpaliya, Head of Global Technology at JPMorgan:
“Banks can be encumbered with legacy systems and hierarchy, but our goal and we are using a lot of data-driven approaches to do this is to make sure that it’s a customer-centric, agile organization that we’re building toward,”
This could be a real gamechanger for JPMorgan, as real change requires a major transformation.
Volatile financials
The company recently announced earnings for the first quarter of 2022 which showed profits had plummeted by 42% as they normalized from the pre-pandemic liquidity boost and added to their loan loss reserves due to Russia exposure. Net interest revenues were up 7.5% year-over-year and 1.9% from the fourth quarter of 2021 due to improvements in loan balances and net yields. JPMorgans provision for credit losses added $1.46 billion, compared to a release of $4.16 billion in the first quarter of 2021. The company pays a healthy 3.2% dividend.
Return on tangible common equity was 16%, which was lower than prior periods, but in line with the long-term average. A positive for the company was that net interest income accelerated by 7.6%, compared to just 2.6% growth in the fourth quarter of 2021. Net interest income is the difference between the income a bank earns from its lending activities and the interest it pays to depositors.
Banks display their financials very different to other companies and often have their income statement laid out differently, thus to avoid confusion, I haven’t provided any charts, as such charts would show high volatility that isn’t really reflective of the business itself. For example, provisons for credit losses often fluctuate depending on market risk, artificially altering the bottom-line.
Valuation
Valuing a bank can be challenging as their financial data has lots of customer deposit information and unique accounting tricks intertwined. In this case, I will use a very simple method: I took a discount rate of 7.4% from Finbox and then used this formula:
“1 / discount rate = justified price-earnings ratio”
“1 / 0.074 = 13.5”
The stock is currently trading at a forward price-earnings ratio of 11.5 based on analysts’ estimates for this year’s earnings and thus appears to be undervalued.
JPMorgan still dominates the U.S. banking market, and with the largest market share in investment banking globally, they are expected to benefit from increasing fees in this area. Their profits look bad after the correction back to pre-pandemic levels and the buildup of loan loss reserves due to Russia’s war on Ukraine.
However, now the stock looks undervalued by my estimates. I think a major transformation and the 25 Mini CEOs is a great idea and the only way for them to maintain their competitive advantage long-term.
This article first appeared on GuruFocus.
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